Free Agency Brings Back Pivotal State Income Tax Issue

The NBA free agency period began hot and heavy on July 1, and for the NHL, it starts July 5. This means, once again, state income taxes are weighing in as these players negotiate for new contracts.

It's hard not to notice the wide swing between some states, like California with the nation's highest state tax rate of 13.3 percent compared to Florida and Texas, both of which have zero state income tax. Tennessee charges professional athletes (visitors or residents) a privilege tax – rather than a state income tax – of $2,500 per game for a maximum of three games per year (pursuant to the new NHL collective bargaining agreement, the legality and constitutionality of this tax is currently being challenged*). Minnesota, which has both NHL and NBA teams, just raised its top state income tax rate to 9.85 percent, which may cause free agents to look south as they make their picks.

When players are courted by teams from more than one state, the decision of which to choose can be complex. Naturally, the variables include a lot more than salary. There's the team itself, the coaches, the reputation, the geography, the climate, where family is located. More and more, it could be that free agents are also giving a lot of weight to what the state income tax situation is before signing a deal.

Of course, there's still the "jock tax," which is the tax some states charge pro athletes who travel to play, train, or otherwise do work for their respective sports team within a state's borders. The tax is calculated on the number of "duty days" a player is in a state, compared to the total days worked, multiplied by the salary.

Recent Months, Other Sports

Mike Wallace left the Pittsburgh Steelers for the Miami Dolphins, landing a five-year, $60 million contract. In the first two years, he's guaranteed $27 million and will save approximately $1.2 million by avoiding Pennsylvania and Pittsburgh taxes. Now with federal tax law limiting how much state income tax can be deducted on a federal return, a state's income tax rates may be a bigger part of the decision than ever.

Phil Mickelson called attention to the issue of state income tax earlier this year when he announced he might take his multimillions to Florida. With the combination of a federal tax hike and a California state income tax hike, the difference in his net income is starting to loom larger in his decisions. Tiger Woods left California years ago for the same reason, saying "I love California but I live in Florida." With the free agency season at hand, it looks like some NBA and NHL free agents may also be eyeballing state income tax as a strong consideration.

LeBron James and "The Decision"

NBA star LeBron James may be the most remembered example of a free agency option. He created a publicity disaster for himself when he became a free agent and entertained offers from franchises other than his Cleveland Cavaliers. He was courted by half a dozen other teams, including four majors: Cleveland, the Chicago Bulls, the New York Knicks, and the Miami Heat. He agonized over "The Decision" (as it came to be known in the media) and in the end, chose Miami. "I'm taking my talents to the South Beach," he told the media. "It's going to give me the best opportunity to win and to win for multiple years."

There's no way to know how much the state income tax question weighed in his decision. At first glance it appeared to be a no-brainer, since going to Miami meant taking a salary of up to $29 million less. Cleveland offered a six-year, $128 million contract, while Miami offered a five-year deal worth up to $99 million. The overall financial picture, however, looked much different. For a player like James, who also had the potential to earn tens of millions in endorsement income each year, salary may have been less of a factor than expected.

In 2010 when he made the decision to leave Cleveland, he left behind a state income tax rate of 6 percent in favor of Florida's no state income tax. Back then, he was also looking at many more millions in estimated earnings from endorsements. Today he expects to earn far more, tens of millions, in fact, in endorsements by the end of 2013. With figures like that, only a rube would not consider the tax picture.

Today's "Decision" could be Dwight Howard, another NBA star being wooed by teams in states where the livin' is easy, at least in terms of state income tax. Read more about his story here.

Do Millionaire Athletes Really Care about the State Tax Factor?

As more and more free agents strike deals, will the teams in Florida, Tennessee, Texas, and Washington have an automatic advantage based on no state income tax? It's hard to say because again, there are many facets to the decision. CPA Robert A. Raiola - who heads the Sports & Entertainment Group for the New Jersey-based accounting firm of Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC - says yes, a state's income tax situation may now weigh into the decision when a free agent looks for a new team.

"State income taxes may not be the number one factor, but certainly, it's part of the equation," Raiola said.

When it comes down to the negotiations table, you can bet the agents from no state income tax teams are going to whip out the numbers, that is, the net income spreadsheets that will dazzle even the most team-loyal players.

"The decision of which team to play for is complex, and money is just one factor," said Raiola. "But looking at the net income between two states, for example, California with state income tax and Florida without, the difference is significant. That leaves us wondering, just how much more would a California team have to pay to make their offer as attractive as an offer from a Florida team?"